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# A Comparative Advantage Model - PowerPoint PPT Presentation

A Comparative Advantage Model . in a Neoclassical World . A Two-Input Economy: A Neoclassical Model. A production function with two inputs: capital and labor Capital and labor are imperfectly substitutable: an increasing cost production function Isoquants Isocosts

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in a Neoclassical World

A Two-Input Economy: A Neoclassical Model
• A production function with two inputs: capital and labor
• Capital and labor are imperfectly substitutable: an increasing cost production function
• Isoquants
• Isocosts
• How does each firm decides on the mix of inputs: the profit maximizing rule
A production function:

Q = f (K, L); given K, as L increases Q will increase;

given L, as K increases Q will increase

Capital, K , and Labor, L, are to some extent substitutable

Both K and L are subject to decreasing returns.

Special cases:

Fixed-proportions production functions

Perfectly substitutable inputs

K

Qx = f (K, L)

Qx1

Qx0

L

0

The Isoquant: A Definition

An isoquant is a curve drawn in a two-dimensional space

representing all the combinations of two inputs (K and L),

measured along the two axes, that can produce a given

level of output.

An isoquant map is a group of isoquants each representing a

certain level of output for a given production function

Isoquants farther from the origin represent higher levels of

output

Isoquants cannot cross

An Isoquant Map

Qx = f (K, L)

K

Qx5 =100

Qx4

Qx3

Qx2

Qx1

Qx0=10

L

0

The slope of an isoquant: the marginal rate of technical substitution (MRTS)

K

Qx = f (K, L)

Slope = ΔK/ΔL = MRTS

A

B

Qx0

L

0

Production Costs: Isocost

Given Q = f ( K, L )

Cost = C = r K + w L where r = price of K; w= price of L

K

C/r

- w/r

L

o

C/w

Equilibrium

Qx = f (K, L)

C = rK + wL

K

MRTS = w/r

C/r

a

b

Qx5 =100

Qx4

c

Qx3

Qx2

Qx1

Qx0=10

L

0

C/w

K

Equilibrium

Qx = f (K, L)

C = rK + wL

Expansion Path

MRTS = w/r

C/r

a

b

Qx5 =100

Qx4

c

Qx3

Qx2

Qx1

Qx0=10

L

0

C/w

A Two-Industry Economy

K

(K/L)c

Kc

Computers

(K/L)R

W/r

KR

Rugs

L

o

Lc

LR

0

K

D

L

L

Y

X

0

K

A production possibilities curve for an Economy with two imperfectly substitutable resources producing two goods:

Rugs

MRS = MRT

U1

Uo

Computers

o

Two Countries

UA

R

UM

R

C

C

o

o

U.S.

Mexico

A two-Country Model

R

R

p

C’

c

f

P’

F’

C

C

o

o

U.S.

Mexico

Can these two countries gain from trade?

Y

Y

Ua

Ub

0

0

X

X

Country B

Country A

Two Countries

UA

R

R

UB

C

C

o

o

U.S.

Mexico

Can these two countries gain from trade?